Decentralized markets where assets are useful as media of exchange are also usually subject to private information. To analyze the liquidity and prices of such assets, I adapt the Shi (1995), Trejos and Wright (1995) model with Lucas trees under adverse selection. While most studies focus on either a pooling or separating equilibrium, I apply the undefeated equilibrium refinement by Mailath et al. (1993) to make the selection based on fundamentals. Under pooling, the high-quality asset holder accepts a pooled price, and under separating signals quality through asset retention. Applying the refinement results in a regime switch from no-information (pooling) to information revelation (separating) following a negative shock to the quality or quantity of lemons. This change leads to a discontinuous fall in aggregate welfare.
- Asset market
- Asymmetric information